THE REVIVAL IN mergers and acquisitions activity is reinjecting vigour into equity capital markets. M&A-related transactions in the third quarter accounted for as much as 27% of ECM volume, compared with just 6.7% over the same period last year. Acquisition-related deals added $13.7 billion to ECM volumes in Europe in the third quarter, and ECM bankers expect more to come.
Some of the biggest deals this year have been M&A related, such as France Telecom’s €3 billion rights issue in September and ABN Amro’s $3.3 billion rights issue in March.
Reasons to be cheerful ECM bankers have good reason to be optimistic that there’s more to come. There are solid long-term drivers behind much of the M&A boom. “A big part of the current M&A wave in Europe is the adjustment of the European corporate landscape to clear changes in the European regulatory environment,” says Paulo Pereira, head of M&A in Europe at Morgan Stanley. “This is particularly true in some sectors where the liberalization and privatization waves of the 1990s created markets out of what were previously protected monopolies and government departments. Fundamental changes in these markets have yet to filter through. There have been major changes over the last 10 years but the corporate landscape looks much the same as it did then. A lot of adjustment is needed just to catch up with the regulatory changes.”
Other factors underpinning the M&A boom, such as the strength of corporate balance sheets and cashflows, also look set to persist well into 2006.
The value of M&A deals in the UK so far this year has already exceeded the $133 billion-worth done in the whole of 2004, and bankers expect a strong finish to the year.
Research by Dresdner Kleinwort Wasserstein shows that there is a regular strong seasonal pattern to M&A volumes. In the UK, the value of M&A rises every quarter from Q1 to Q4, and the volume of M&A rises from Q1 to Q3. Given this reliable trend and the strength of other drivers, a bumper fourth quarter is likely.
A couple of factors could upset the boat. The cheapness and availability of finance is extremely important for M&A, so further interest rate rises could have a dampening effect.
The most crucial factor, though, is the strength of secondary markets. DrKW estimates that the correlation between M&A volumes and equity markets since 1995 is 0.83, which suggests that much M&A activity is sentiment driven. ECM bankers, however, are almost entirely dependent on the strength of stockmarkets for the health of their businesses anyway.
Positive thing No matter how many deals they do, ECM bankers always seem happy to do more. M&A-related transactions, however, are particularly welcome as they have the added benefit of being highly profitable, unlike much ECM business. Most accelerated deals and block trades, which, according to Dealogic, have made up 52% of ECM business in Europe so far this year, are intensely competitive, low-margin, commoditized affairs. Although they account for more than half of all ECM business, overnight deals are estimated to account for just 21% of ECM revenues.
“The growing impact of M&A-related transaction volumes is a positive thing for the ECM business,” says Sam Dean, head of European ECM at Deutsche Bank. “There is a different mentality to doing an M&A-linked deal compared with a straight equity sell-down. The seller cares more about the aftermarket. The way investors and the market respond is not the primary concern to a vendor selling someone else’s equity, but it is in M&A deals. People want to do sensible, well-priced deals because the market’s reception means more to them – it’s their stock.”
M&A is changing the composition of ECM product issuance too. The volume of rights issues in the third quarter was 35% up on the first and second quarters combined. Rights issues in 2005 have been almost exclusively linked to acquisition financing, a dramatic contrast to a few years ago when rights issues were predominantly used for balance sheet repair.
Rights issues Whether or not a company seeking to raise equity to fund an acquisition with cash opts for a rights issue or a secondary sale depends mainly on the size of the deal. A company might have the right to raise a certain amount of equity without going back to its existing shareholders, in which case it could opt for a secondary sale if the amount it needed to raise was within those bounds. If the amount it sought to raise was greater, it would need to make a rights issue.
Allianz, for example, did not need to do a rights issue to fund its bid for the remaining 45% of shares it did not already own in Italian insurer Riunione Adriatica di Sicurtà. Instead, Allianz raised €2 billion in an innovative secondary placement in which it borrowed 10.7 million shares from existing investors to sell to others, in order to mitigate the risk of issuing shares unnecessarily should its acquisition fail. It also placed 10.1 million new shares in a straightforward sale.
Good news The fact that fund managers are flush with cash at the moment and are unusually welcoming to M&A ideas is also good news for equity capital markets.
This October, EFG Bank, a Swiss wealth manager, raised SFr1.4 billion ($1.1 billion) in an IPO. The rationale for the deal, Switzerland’s biggest IPO this year, was to build a war chest to fund acquisitions. The fact that investors were willing to provide so much money for unspecified acquisitions to the company, which is just 10 years old, surprised even some bankers close to the deal. Such demand for the IPO – seven times oversubscribed – would have been inconceivable a few years ago.
“Liquidity is out of control,” says the co-head of ECM at a bulge-bracket bank. “It’s phenomenal.”
The growing importance of M&A as a source of ECM deals has significance for league table rankings. “M&A is the wild card in the ECM world,” says Viswas Raghavan, head of equity and equity-linked capital markets at JPMorgan. “It will swing the fortunes of the banks. Just as blocks are now distorting league tables, banks with strong M&A businesses stand to benefit.”
Advisers Some companies will use different banks for M&A advisory and equity financing. However, it is most common to use a group of banks including the adviser. An adviser would have to be very unlucky indeed to be excluded totally from the equity ticket.
The greater profitability of M&A-linked ECM deals also means that there will likely be a wider discrepancy between league tables based on volume and league tables based on revenue.
With just 0.9% of market share separating the top four bookrunners in EMEA, league tables competition is fierce. The danger, as ever, is that banks that lose out on M&A-related business because a weak M&A franchise will try to compensate by bidding overly aggressively for blocks.
